Reference no: EM132459146

Problem: The probability that the economy will experience a recession next year is 0.3, while the probabilities of moderate growth or rapid expansion are 0.5 and 0.2, respectively. The stock of Firm A is expected to return 5%, 15%, or 20%, depending on whether the economy experiences a recession, moderate growth or rapid expansion, respectively. The returns for Firm B are expected to be 0%, 16% or 30%, respectively.

Required:

Question 1: Calculate the expected returns for each firm's common stock.

Question 2: What is the variance to the return for Firm A and B common stock?

Question 3: What is the standard deviation of the rate of return for firm A and B common stock?

Question 4: According to CAPM, the expected return on a risky asset depends on three components. Describe each component, and explain its role in determining expected return.